How will the Saudi Arabia-Iran face-off impact oil market?

FXStreet (Mumbai) - It is common knowledge that Iran and Saudi Arabia are the primarily followers of the Shiite and Sunni sects in the middle-east region. When Saudi Arabia executed Nimr al-Nimr, a prominent Shiite cleric on Saturday they further stoked fears of another crisis in the already disturbed and war torn region. Iran's Supreme Leader Ayatollah Ali Khamenei warned "divine revenge" awaits the Sunni Muslim kingdom as the act has angered Shia Muslims elsewhere in the Middle East.

Following his execution a wave of protests broke out. Iranian protestors stormed the Saudi embassy in Tehran, destroyed property and set fire. Saudi Arabia’s embassy in Baghdad was attacked as well. Iran accused Saudi Arabia of fanning tension in the region. Iran's foreign ministry spokesman, Hossein Jaber Ansari told the Iranian state news agency "The Saudi government supports terrorists and takfiri [radical Sunni] extremists, while executing and suppressing critics inside the country". Saudi government yesterday declared the kingdoms’ decision to severe diplomatic ties with Iran.

The blame game is at its peak. Saudi Foreign Minister Adel al-Jubeir accused Iran of distributing “weapons and planted terrorist cells in the region". Iranian officials also expressed their contempt for the Saudi’s support for Islamist groups.

Political experts are afraid that this cut off in diplomatic ties will escalate tension in the region as countries will soon join either side in the war rage against opposite sects. It is almost certain now that diplomatic row will spread to Lebanon, Yemen or Iraq, providing ample scope to militant group Islamic State to use inter-sect tensions to their advantage in the region. Kamran Bokhari, author of "Political Islam in the Age of Democratization," has warned "Both sides are gearing up for escalation; we are going to see more and more escalation as we move forward”.

US state department spokesman John Kirby who feels “diplomatic engagement and direct conversations” are essential at this juncture said, “We will continue to urge leaders across the region to take affirmative steps to calm tensions".

Oil supply may be disrupted?

As tensions rose between Saudi Arabia and Iran, oil prices increased fears of supply disruption. Benchmark U.S. WTI light sweet crude was up 1.9 per cent at $37.76 a barrel early afternoon in Asia, while Brent crude was up 2.3 per cent at $38.12 a barrel. Investors are worried as most of the Saudi oil comes from its Eastern Province dominated by Shiites.

Bernstein's senior oil and gas analyst Neil Beveridge feels the execution of the Shiite cleric will cause disturbance as protests break out, affecting oil production and supply. Beveridge told CNBC today "This is the area that could potentially suffer if there is an escalation in tensions between Saudi Arabia and Iran”. Saudi Arabia produces about 10 million barrels of oil a day, while Iran's output is about 3 million barrels a day. Beveridge thus feels markets will have to suffer the consequence of any possible disruption in production or shipping.

How far oil supply gets affected by the Saudi Arabia-
Iran face off remain to be seen. It must be noted that an Iranian official had earlier argued “We’ve already reduced our production due to sanctions,” referring to the 1 million barrels a day of output the country lost after sanctions were imposed in 2012. The official said the Saudis benefitted from Iran’s loss. This raises the question whether Iran will allow a crisis like this to affect its oil production; particularly as it gears up to increase export post the removal of sanctions.

IG market strategist Evans Lucas also feels that Saudi Arabia might choose to increase production to ‘counter any fallout from the conflict with Iran’. In this event, oil might dip to $20 a barrel as other non-OPEC nations continue to pump higher volumes.

However, though oil gained from this crisis, Juerg Kiener, managing director and chief investment officer of Swiss Asia Capital in Singapore feels that the risk premium for current Middle Eastern tensions are "incredibly low”.
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